Oregon banks buy some time

Federal bank regulators didn’t mince words the last time they met with new Bank of the Cascades CEO Terry Zink.

They wanted to know excruciating detail about several of the bank’s loans.

The loans were categorized in a previously unused column of the balance sheet called TDRs, or troubled debt restructurings.

Such loans work like this: Say an apartment developer hits a financing snag and can’t immediately start construction on a new project. Instead of foreclosing on the land, a bank can restructure the loan and give the developer some leeway until the market improves.

The practice is legal, but regulators are increasingly worried that banks are using it to sweep bad loans under the rug, prolonging the economic recovery and putting more banks at risk of failure.

The Wall Street Journal reported last year that the Securities and Exchange Commission has launched a probe into how banks account for restructured loans.

“There’s a sense that in some cases banks are using TDRs as a way to kick the can down the road with no real outcome,” Zink said. “(The regulators) feel banks are using the TDR method to just prolong what may be the inevitable.”

$285 million and counting

Zink didn’t have much to worry about in his conversation with regulators.

Bank of the Cascades has less than $1.9 million in restructured loans on its $1.3 billion balance sheet, down from $17.9 million in June of last year.

It’s not possible to predict whether any Oregon banks will get singled out for restructuring loans.

Portland’s Umpqua Bank, the largest bank based in Oregon, has the most restructured loans in the state, not surprising because it’s the state’s biggest bank by nearly a factor of five.

Umpqua had roughly $48 million in restructured loans at the end of 2011, less than 1 percent of its loan portfolio.

The bank didn’t immediately return a call for comment, but its annual report devotes three pages to spelling out its policy for restructuring loans. Most of its restructured loans are for commercial real estate.

The banks with the highest percentages of restructured loans:

• Eugene’s Century Bank (nearly 8 percent of its $66.3 million portfolio).

Before the economic crash in 2008, Oregon banks didn’t have a single restructured loan.

Today they have roughly $285 million of them, a number that represents more than $1 of every $100 in outstanding loans at Oregon banks.

It’s also the only troubled asset class still growing, increasing 16 percent in the last year and 103 percent in the last two years.

Bad loans, on the other hand, decreased 30 percent last year to $947 million statewide. Foreclosed real estate owned by Oregon banks fell 15 percent to $248 million.

Restructuring troubled loans is legal, but is fraught with uncertainty.

“The key is it has to be a borrower experiencing financial difficulty and it has to be a concession,” said Michael Lundberg, a partner in the audit group in the Des Moines, Iowa, office of the accounting firm McGladrey & Pullen LLP. “It could be any number of modifications or changes to the loan terms. At the heart it’s designed to help that borrower with that tough spot without pushing the borrower into foreclosure.”

Regulators say some loans have been restructured without meeting that basic criteria.

“We see a lot of that,” said Jacob Mundaden, banking program manager for Oregon’s Division of Finance and Corporate Securities.

Although some refer to the practice as “extend and pretend,” banks say it allows them to set aside less cash to cover potential losses, keeping more capital available for new loans.

It also means banks can avoid the costly process of foreclosing on a property — and paying taxes on it — until it can be sold. Not to mention, the foreclosure process can ding the market value of a property, another reason to restructure a loan instead of foreclosing on it.

“The issue is that banks will modify these loans and give them kind of a sweetheart deal and then say, ‘Look they’re performing. These loans are OK. They’re not past due,’” Lundberg said. “The accountants and regulators are saying, ‘Yea it’s performing, but only because you gave them this great deal. If you hadn’t done this they couldn’t have made the original payment obligation.’”

Zink said regulators are worried banks aren’t setting aside enough capital to cover future losses on sour loans that will likely never recover.

“They’re not so much concerned with whether or not you have a TDR,” Zink said. “What they’re concerned about is your ability to withstand a loss on those TDRs if they don’t work out.”

‘Moving the goal posts’

Bankers and accountants say one of the biggest difficulties with restructured loans is changing guidance from regulators.

Zink said some bankers feel like regulators are “moving the goal posts a little bit” because of new rules.

Mundaden said a lot of the confusion traces back to a federal edict in 2009 that seemed to encourage the use of troubled debt restructurings in order to work out problem loans.

“The accounting guidance is not very clear,” he said. “Since the guidance is not clear it leads to inconsistent treatment in accounting.”

Some bankers have also complained that the application of the rules varies from regulator to regulator, forcing some banks to shift good loans into the sour loan pile because of overzealous regulators.

The Federal Deposit Insurance Corp. has held numerous teleconferences, seminars and conference calls to discuss the issue in the past year. The agency couldn’t immediately make someone available to comment.

“There’s a sense that they need to tighten up how they’re viewing some of these problem credits,” Zink said. “It’s an area where up until the current economic crisis it never really got looked at.”

While regulators are worried about restructured loans, bank analysts aren’t too concerned about it. Most take a simple approach to gauging a bank’s health by just lumping all restructured loans in with a bank’s sour loans.

“That’s the only way I know how to do it,” said Blake Howells, a vice president and bank analyst at Portland-based Becker Capital Management.